Bernanke Passes The Buck

In a speech
at the Economics Club in Washington, Federal Reserve (Fed) Chairman Ben
Bernanke warned America to save more and spend less to preserve our standard
of living for the long-term. The core of his message that we must improve
fiscal discipline and the quality of our education is not new; his advice
will also be applicable as long as we have politicians and schools. The speech
is more striking for what was not mentioned - namely the Fed's role in this
process.

We know that the retirement of baby boomers poses enormous challenges. Bernanke
expressed the urgency of fiscal policy reform to pave the way for either greater
government revenues or lower expenses. It seems like everybody likes to talk
about the need for greater savings, but no politician wants to have it take
place while they are in office. The reason is simple: in the short-run, greater
savings tend to come with less spending: increased savings could signal a recession.

Bernanke is not a lawmaker, he is the Chairman of the Federal Reserve. In
this role and in conjunction with the Federal Reserve Board, he oversees monetary
policy. Monetary policy should be primarily concerned with preserving purchasing
power by setting interest rate and money supply targets. And while not mentioned
in Bernanke's speech, the Fed has an enormous influence over the spending and
savings habits of both consumers and government. Overly accommodating monetary
policy pushed consumers into debt after the technology bubble burst. Shortsighted
fiscal policy has also contributed to the poor state of the American consumer
("lower taxes get more money into consumers' pockets"), but the Fed has plenty
of its own housecleaning to do before scolding politicians that they behave,
well, like politicians.

In our view, the right medicine to foster savings and investments would be
for the Fed to tighten money supply through higher interest rates, by imposing
stricter lending standards and directly reducing money supply through market
intervention. The Fed is best positioned to encourage savings and investments,
to put a dampener on consumption. Small cuts in consumptions now could preserve
much more painful cuts in the future.

Why doesn't the Fed prescribe his medicine rather than passing the buck to
Congress? Because the economy is too leveraged, too interest rate sensitive.
As consumers nowadays buy just about everything on credit and have loads of
debt, higher interest rates today hit them harder than they would have twenty
years ago. Indeed, the current interest rate environment has already started
to deflate the housing market and has put in motion an economy that may slide
into recession. Increasing interest rates sufficiently to force a cut in consumption
risks inducing deflation and a depression.

While much tighter monetary policy may be the right medicine to prepare us
for the demographic challenges ahead, it is not one the Fed under Ben Bernanke's
leadership is likely to prescribe. In his research about the Great Depression
before becoming Fed Chairman, Bernanke identified the strong dollar as one
of the culprits that made the Depression more severe. He has also praised the
Japanese ultra-loose monetary policy to fight deflation. Aside from preserving
our standard of living in the long run, the dollar should benefit from what
would amount to a radical shift in Fed policy. Right now, the US is dependent
on over US$ 2 billion in inflows from overseas investors every single day,
just to keep the dollar from falling versus a basket of currencies; the inflows
are required to finance the current
account deficit. If we were to save more, we would be less dependent on
foreigners to keep the dollar afloat. However, in the absence of a clear commitment
by the Fed to transform the US into a nation of savers and investors, a weaker
economy is likely to be accompanied by a weaker dollar: as the economy weakens,
foreigners may be less inclined to invest in the US and thus exert downward
pressure on the dollar.

It comes as no surprise to us that Bernanke would tell Congress to jump over
its own shadow and pass entitlement reform rather than to impose reform through
monetary policy. But as Bernanke said, "...the imperative to undertake reform
earlier rather than later is great." Ironically, in the absence of an agreement
on entitlement reform, the politically most convenient solution is a devaluation
of the dollar. In such a scenario, nominal promises can be kept, but the purchasing
power of benefits erode. While this is a likely scenario, it is a risky one
as side effects may include significant inflation: we cannot always count on
globalization to bail us out by keeping consumer prices low.

The recent volatility in the price of gold reflects the odds that we may actually
be heading towards a deflationary recession. While possible, we believe we
will have lower short-term interest rates a year from today as the Fed will
loosen monetary policy to give support to an ailing economy. In the months
to come, it may become increasingly apparent that the dollar and its purchasing
power are less important to the Fed than the pain that would be suffered by
a significant portion of the population if monetary policy was too tight.

We manage the Merk Hard Currency Fund, a fund that seeks to profit from a
potential decline in the dollar. To learn more about the Fund, or to subscribe
to our free newsletter, please visit www.merkfund.com.

Axel Merk, President & CIO of Merk Investments, LLC, is an expert on hard
money, macro trends and international investing. He is considered an authority
on currencies.

The Merk Absolute Return Currency Fund seeks to generate positive absolute
returns by investing in currencies. The Fund is a pure-play on currencies,
aiming to profit regardless of the direction of the U.S. dollar or traditional
asset classes.

The Merk Asian Currency Fund seeks to profit from a rise in Asian currencies
versus the U.S. dollar. The Fund typically invests in a basket of Asian currencies
that may include, but are not limited to, the currencies of China, Hong Kong,
Japan, India, Indonesia, Malaysia, the Philippines, Singapore, South Korea,
Taiwan and Thailand.

The Funds may be appropriate for you if you are pursuing a long-term goal
with a currency component to your portfolio; are willing to tolerate the risks
associated with investments in foreign currencies; or are looking for a way
to potentially mitigate downside risk in or profit from a secular bear market.
For more information on the Funds and to download a prospectus, please visit www.merkfunds.com.

Investors should consider the investment objectives, risks and charges
and expenses of the Merk Funds carefully before investing. This and other
information is in the prospectus, a copy of which may be obtained by visiting
the Funds' website at www.merkfunds.com or calling 866-MERK FUND. Please
read the prospectus carefully before you invest.

The Funds primarily invest in foreign currencies and as such, changes in
currency exchange rates will affect the value of what the Funds own and the
price of the Funds' shares. Investing in foreign instruments bears a greater
risk than investing in domestic instruments for reasons such as volatility
of currency exchange rates and, in some cases, limited geographic focus,
political and economic instability, and relatively illiquid markets. The
Funds are subject to interest rate risk which is the risk that debt securities
in the Funds' portfolio will decline in value because of increases in market
interest rates. The Funds may also invest in derivative securities which
can be volatile and involve various types and degrees of risk. As a non-diversified
fund, the Merk Hard Currency Fund will be subject to more investment risk
and potential for volatility than a diversified fund because its portfolio
may, at times, focus on a limited number of issuers. For a more complete
discussion of these and other Fund risks please refer to the Funds' prospectuses.

This report was prepared by Merk
Investments LLC, and reflects the current opinion of the authors. It
is based upon sources and data believed to be accurate and reliable. Merk
Investments LLC makes no representation regarding the advisability of investing
in the products herein. Opinions and forward-looking statements expressed
are subject to change without notice. This information does not constitute
investment advice and is not intended as an endorsement of any specific investment.
The information contained herein is general in nature and is provided solely
for educational and informational purposes. The information provided does
not constitute legal, financial or tax advice. You should obtain advice specific
to your circumstances from your own legal, financial and tax advisors. As
with any investment, past performance is no guarantee of future performance.